The Daily Prophet: Markets Suffer From Lack of Follow Through

Connecting the dots in global markets.

The reports over the weekend were almost euphoric: It was going to be a very good holiday season for retailers and the economy more broadly, based on initial indications of retail sales. And yet, the S&P 500 Index was under pressure all day Monday, struggling to gather any positive momentum.

Whether it was a case of buy on the rumor and sell on the news after the strong run in stocks since Mid-November, or just a case of sales meeting lowered expectations, the fact that equities did a whole lot of nothing is a bit concerning. That's because it shows companies and the economy are at the point where they will likely need to outperform, not just meet forecasts, to justify lofty valuations. The SPDR S&P Retail ETF is essentially flat compared with Nov. 23, the day before the Thanksgiving holiday in the U.S., even though Bloomberg Intelligence reported that store visits over the Black Friday weekend at malls showed more traffic than in prior years, with an increasing number of consumers shopping versus just browsing.  

 It doesn't help the bulls that stocks globally are about to enter a "trickier" period, according to Morgan Stanley. The firm's strategists say equities in 2018 are unlikely to outperform the real economy. In terms of the S&P 500, they see the gauge rising 5.7 percent to 2,750 from 2,601.42 on Monday, adding that they "would not be surprised if we reach that target" during the first half of 2018 "and it marks the high for the year."

Oil is also suffering from a lack of follow. The members of OPEC and Russia will meet in Vienna this week to discuss extending production cuts. Much of the pre-meeting media coverage over the weekend centered on how the cartel has been successful in curbing output and lifting the price of crude back above $50 a barrel. And yet, oil prices fell 1.29 percent on Monday to $58.19 a barrel. Like stocks, oil has had a big run, advancing about 23 percent since the start of September, and Monday's drop may just be a temporary adjustment on the way to higher prices, but what's concerning are the reasons that analyst are giving for Monday's weakness in crude. Although OPEC and Russia crafted the outline of an agreement to extend production curbs to the end of next year, according to people involved in the discussions, Bloomberg News' Catherine Traywick reports that doubts remain over the size of the reductions after the current accord expires in March, as well as which exit strategy the group will adopt. Meanwhile, drillers targeting crude in the U.S. added nine rigs last week. "What we’re seeing is cold feet heading into the OPEC meeting," said Ashley Petersen, lead oil market analyst at Stratas Advisors in New York. "After exuberance over three weeks now, investors are getting nervous. That’s going to be the dominant driver regardless of the weekly fundamental data."

Despite the lack of inflation, bonds that protect investors against faster inflation sure are doing well. The Bloomberg Barclays Global Inflation-Linked index has gained 1.94 percent this month, the most among the 19 major indexes and topping the 1.33 percent gain in the benchmark Bloomberg Barclays Global Aggregate index. Bloomberg News' Sebastian Boyd reports that Bank of America data show that the week through Nov. 21 was the third-biggest for inflows into Treasury Inflation-Protected Securities ever. There may still be time to get in. Boyd reports that T. Rowe Price portfolio managers Steve Huber and Stephen Bartolini say TIPS have yet to price in the potential for faster inflation if CPI, buoyed by a weak dollar and a tight labor market, reverts to trend next year. At the least, the performance of so-called linkers may help bolster one explanation for the narrowing of the U.S. yield curve, or the gap between short- and long-term bond rates. A narrow curve is typically associated with a looming slowdown in the economy, which tends to curb inflation and benefit longer-term bond yields. But since inflation expectations may be on the rise, as measured by the performance of linkers, then maybe the narrower yield curve is less a referendum on the economy and more a reflection of foreign investors grabbing the historically high yields offered on U.S. debt relative to the rest of the developed world.  


If the outlook for the U.S. economy looks so promising, than how does one explain a slowdown in corporate borrowing? Weekly Federal Reserve data on commercial and industrial loans hasn't been robust in 2017, with the amount outstanding growing just 1 percent, compared with an average of 9.9 percent in each of the last six years. In fact, the trend has been downward since late September. This doesn't jibe with the booming stock market, which keeps hitting new highs, so investors could be in for a nasty surprise. Peter Boockvar, the chief market analyst at The Lindsey Group, wrote in a research note that he can think for four reasons why loan growth is slowing. First, companies are bypassing bank loans and getting cheaper funding in the capital markets. Second, Libor-based are getting more expensive and companies are choosing not to borrow. Third, corporate debt levels at or near historic highs relative to GDP and cash flow is resulting in a pause in further borrowing. Fourth, companies are waiting until tax reform actually passes before making big corporate spending decisions. Of those reasons, No. 3 seems to fit with the Fed's quarterly survey of senior loan officers at banks, which shows that demand for commercial and industrial loans has fallen to their lowest levels since early 2012.

The rand had its best day since March, rising  2.80 percent after Moody's Investors Service on Friday decided against cutting South Africa's credit rating to below investment grade, or junk. The alternative would have been devastating for the currency, as it likely would have forced international investors who can only own the bonds of countries with high-grade ratings to dump their holdings. The reprieve means South Africa retains its position in Citigroup’s World Government Bond Index. An exit from the index would have sparked outflows of as much as $10 billion, according to Societe Generale. The currency has been on a roller-coaster ride this year as political infighting curbed efforts to boost Africa’s most industrialized economy, according to Bloomberg News' Dana El Baltaji and Colleen Goko. Since Finance Minister Pravin Gordhan was fired in March, the nation’s foreign-credit grade was cut to junk by two ratings firms and economic growth stalled. South Africa isn't out of the woods yet. Moody's said it may still cut the rating, which is currently at Baa3, after the February budget. The government is considering measures over the next two weeks that will combine tax increases and spending cuts to save 40 billion rand ($2.91 billion) in fiscal 2019.

Jerome Powell takes another step toward becoming the next chairman of the Fed when he sits down for his confirmation hearing Tuesday with Republican and Democrat senators. The current Fed governor will likely try to offer a balanced message: convincing Republicans that he’ll take a fresh approach to monetary policy, while assuring Democrats he won’t dismantle bank regulations or dramatically depart from current Fed Chair Janet Yellen’s cautious stance on raising rates, according to Bloomberg News' Christopher Condon and Elizabeth Dexheimer. They note that in five years as a Fed governor, Powell has publicly supported the policies of Chairs Ben Bernanke and Yellen, leaving many observers to wonder whether his comments reflected his own views or his loyalty to the leadership -- regardless of party affiliation. The economists at Bloomberg Intelligence say the hearing will also give senators an opportunity to probe the central bank's persistent undershooting of its inflation objective as well as the potential policy response to tax reform.

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Forecasters Are Too Downbeat About U.S. Growth: Neil Dutta

War of Words Threatens to Upend OPEC Meeting: Jason Schenker

U.S. Coal Industry Shows No Sign of Comeback: Shelley Goldberg

What the Renewed Uptick in Stocks Tells Us: Mohamed A. El-Erian

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